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The Federal Reserve and European Central Bank have for a long time now been wrestling with a problem that is truly novel. They find themselves in an interest rate trap, which means they need to restore borrowing rates to something close to the historic norm, but doing so puts the global banking system at risk. The political class is just as hooked on cheap money as the bankers, so their is no appetite for a Paul Volker like approach to solving the money problem in the West.
For a long time, the problems were abstract. Everyone knew that near zero interest rates would one day create big problems, but in the here and now they made all of the important people happy. The reckless and insane response to Covid by Western ruling classes moved the problem into the domain of reality. Massive spending by government put enormous amounts of cash into the hands of regular people, not just the bankers, and those regular people started spending it.
Compounding this was the decline in global demand for dollars. Since the 1990’s, the Chinese economy was able to soak up extra dollars and euros. Other parts of Asia could also be counted on to take dollars in the form of investment. The massive liquidity in the banking system was, in effect, sequestered from the retail economy of Western countries, so the impact was low. That and the rest of the world was happy to hold euros, dollars and bonds in those currencies.
Covid was an accelerant in many ways, but one very important way was in regards to the Chinese economy. Central to the long term plans of China is to boost domestic demand and reduce her dependence on exports to the West. Lock downs and the subsequent decline in global commerce accelerated the process. China came out of Covid with far less demand for Western investment. Those extra dollars and euros are retuning to their makers.
It is looking like the insane response by the collective West to the war in the Ukraine is another accelerant to a process that was slowly building steam. Cutting Russia off from the “rules based international order” was a wake up call for the large, non-Western economies of the world. China understood right away that the dollar was Washington’s primary weapon in international affairs. The Saudis also came to see the problem with depending upon Washington to abide by the rules.
More important, the Russian economy survived the assault by Washington and she successfully defended the ruble. When Russia demanded payment in rubles from Western nations and they went along with it, the world changed. All of a sudden, the multipolar world with multiple competing currencies came into focus. China, Russia, India and the OPEC countries have now set off on a path where the dollar and euro no longer have a special place in global trade.
The enormity of this politically and economically cannot be overstated. This week the ruler of China is making a visit to Moscow. Generations of American policy makers have worked to avoid this meeting, but the current crop in charge of American foreign policy wrecked all of that and now we have an alliance between Russia and China. The world’s largest economy is now a strategic partner with the world’s biggest nuclear power, in opposition to the Global American Empire.
The global realignment does not stop there. The Russians have been brokering a peace between the Turks and the Syrians. The goal is to squeeze out the Americans, who are in Syria stealing Syrian oil and gas. China has brokered a deal between Saudi Arabia and Iran, which promises to reorder the region. The oil producing hub of the world is suddenly in the orbit of China and Russia. Economics follows politics, so it is not hard to see what this does to the dollar and euro.
For the last year, the Fed and ECB have been facing a problem. There is far too much money in the system and the demand for their money is in decline globally, which means they have to remove money from the system. They tried to ignore the problem by spinning yarns about inflation being transitory, but rocket high food bills made that story impossible to maintain. The politicians demanded the Fed “fix” the economy for them, so the Fed started to raise rates.
That is what brings us back to the interest rate trap. The entire Western banking system depends on exclusive access to cheap money. This is their margin. They no longer provide much in the way of essential services. Much of what the banking system does could be automated at this point. The profits come from operating a casino in which the house arbitrages the difference between what it pays for money and what the suckers on the other side pay for money.
If all of a sudden the price the house pays for money closes with that which the suckers are paying, then the casino goes bust. That is what we are see now. Silicon Valley Bank and Signature Bank were just money laundering schemes for plutocrats. Once interest rates went up just a little, they were no longer viable. Credit Suisse was just bailed out by the Swiss National Bank for the same reason. These banks could only exist in the world of free money to the banks and their clients.
Over the weekend, the Fed with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank announced a global bailout of the Western banking system. They are offering unlimited cash in exchange for the illiquid assets on the bank’s books. The reason they did this is they know that every bank in the West has the same problem as Credit Suisse. That is their liabilities outweigh their assets so they are effectively broke.
Of course, you cannot fight inflation while showering the system with cash, which means the effort to rein in inflation has come to an end. The Fed will try to limit the swapping of bad assets for cash by substituting treasuries, but this sort of legerdemain is just so they can continue the game of make believe. High inflation is now the new normal in the West because it is impossible to raise rates. The West has turned itself into Argentina through bad policy and worse politics.
For generations now people have warned about the long term cost of living on borrowed money, but they were mostly wrong. Living on borrowed money is self-correcting in that the lender eventually stops lending. What the West faces is a problem where the lender cannot not stop lending. The only way to sustain this now is for the people to be impoverished through systemic inflation. Inflation is now the banker’s friend, because it promises to keep the cheap money flowing.
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